Commentary and musings on the complex, fascinating and peculiar world that is securities regulation

Tuesday, October 11, 2011

House Panel Approves Crowdfunding Legislation to Help Create Jobs

A House panel approved legislation sanctioning crowdfunding to finance new businesses by allowing companies to accept and pool donations up to $5 million without registering with the SEC. Crowdfunding is an innovative and lower-risk form of financing that enables several individuals to pool money to invest in a particular company. The Entrepreneurial Access to Capital Act, HR 2930 is sponsored by Rep. Patrick McHenry (R-NC), who noted that new ideas are needed to help provide small businesses and entrepreneurs with the ability to create jobs. In his view, the legislation will connect entrepreneurs with everyday investors to help get their businesses off the ground. Generally, the term “crowdfunding” is used to describe a form of capital raising whereby groups of people pool money, typically comprised of very small individual contributions, to support an effort by others to accomplish a specific goal.

The subcommittee rejected an amendment proposed by Rep. Al Green (D-TX) that would have precluded persons convicted of a violation of federal or state securities laws or subject to disqualification from such laws from participating in the crowdfunding exemption. Similarly rejected was an amendment offered by Rep. Carolyn Maloney (R-NY) that would have required the issuer of the securities to give the SEC notice of the issuance and required the SEC, in turn, to make the notice available to state securities regulators.

Specifically, HR 2930 would provide a crowdfunding exemption to SEC registration requirements for firms raising up to $5 million, with individual investments limited to $10,000 or 10 percent of an investor’s income. The exemption would erase limits on the number of investors until the first $5 million of capital is raised. The legislaiton is designed to provides smaller investors an opportunity to support startups that is currently not an option under SEC regulation.

Further, the legislation is crafted to represent a point of agreement between Republicans and the White House regarding regulatory reform in the President’s jobs bill. In a recent fact sheet set forth with the introduction of the draft legislation, the American Jobs Act, the Administration expressed support for a number of measures designed to reduce the regulatory burdens on small business capital formation: As part of the President’s Startup America initiative, the Administration will pursue efforts to reduce the regulatory burdens on small business capital formation in ways that are consistent with investor protection. The Administration generally supports establishing a crowdfunding exemption from SEC registration requirements.

SEC rules previously included an exemption, Rule 504, which allowed a public offering to investors (including non-accredited investors) for securities offerings of up to $1 million, with no prescribed disclosures and no limitations on resales of the securities sold. These offerings were subject only to state blue sky regulation and the antifraud and other civil liability provisions of the federal securities laws. In 1999, that exemption was significantly revised due in part to investor protection concerns about fraud in the market in connection with offerings conducted pursuant to this exemption. In assessing any possible exemption for crowdfunding, SEC officials told Congress that it would be important to consider this experience and build in investor protections to address the issues created under the prior exemption. See testimony of Lona Nallengara, Deputy Director, Division of Corporation Finance, before House Capital Markets Subcommittee, Sept 21, 2011.

The Deputy Director also noted some questions to consider with regard to crowdfunding including what information, for example, about the business, the planned use of funds raised, and the principals, agents, and finders involved with the business, should be dsiclosed to investors and what restrictions should there be on participation by individuals or firms that have been convicted or sanctioned in connection with prior securities fraud. There should also be an examination of whether an SEC filing or notice should be required so that activities in these offerings could be observed. In addition, there are questions of whether securities purchased should be freely tradable and whether websites that facilitate crowdfunding investing should be subject to regulation.